The Sweet Breath of Justice

Secretary of State James F. Syrnes signs agreement for $4,400,000,000 loan to Great Britain by the United States during ceremony at State Department in Washington on June 12, 1945. (AP Photo)

I was at Brookings Institution today for this presentation, which reminded me of some history…

By September 1945, the war in Europe was over and Japan had surrendered. And, suddenly, the U.S. ended Lend Lease — the program that for five years had provided assistance to the allies fighting alongside the U.S., principally the Soviet Union and the U.K. The abrupt termination of Lend Lease came as a shock to the U.K. Government and especially to John Maynard Keynes, who had worked tirelessly with the Americans to develop "rules of the games" for the post-war economy, securing agreement a year earlier at Bretton Woods, New Hampshire. The U.K. faced financial collapse, labouring as it was under a staggeringly high debt burden and with its foreign exchange reserves having been exhausted by the financial exigencies of single-handedly (albeit with the loyal assistance of her overseas Dominions) opposing the tide of Nazi aggression long before the U.S. entered the war. That valiant struggle would, London had hoped, count for something in Washington's calculus. It seemingly did not.

In these circumstances, Keynes was once more dispatched to negotiate financial terms with the U.S. Treasury. In framing the U.K.'s negotiating position for his political masters, Keynes identified three options: Austerity, Temptation and Justice. The first option, which he derided as "Starvation Corner," entailed retrenchment from global "responsibilities" (as Whitehall viewed them) or "colonial privileges" (as the U.S. undoubtedly understood them to be); deferral of the “New Jerusalem” social policies the recently-elected Labour Government had promised to a war-weary nation; and acceptance of drastically reduced living standards and years of strict wartime rationing. Succumbing to "Temptation," meanwhile, would require agreement to loans on U.S. terms, which would also entail rationing and economic hardship, and the forfeiture of national sovereignty to the U.S. Treasury over exchange rate and commercial policies. Instead, Keynes convinced the Cabinet to fight for "Justice" or access to loans on very favorable terms — essentially, Keynes sought an interest-free loan with a very long maturity that would be “grant like” — returning to an early accession to the terms of the Bretton Woods agreement, particularly the removal of restrictions on current account transactions.

Although he tried to bluff his way to Justice, Keynes had been dealt a very poor hand indeed. The simple fact is that by September 1945 the U.S. held all the aces; even the argument invoked by the U.K. that it was owed special treatment given its lone stand in 1940 fell on deaf ears. In part, this was because of the U.S. Administration’s insistence that thousands of American GIs did not die to allow the old imperial powers of Europe to re-establish their colonial possessions. Offering the U.K. generous terms would be tantamount, it was feared, to underwriting the status quo ante: U.S. Treasury Secretary Vinson informed Keynes that, if London was worried about the massive sterling-denominated debt it owed to India that would be unblocked by making sterling convertible to the dollar, the U.K. could, in effect, do a debt exchange for independence.

So, it isn't (or shouldn't be) a surprise what happened: Keynes was unsuccessful. Recognizing that the British population would not stand for “Starvation Corner,” the U.K. succumbed to “Temptation.” The U.K. hunkered down to austerity and continued rationing; a famous telegram from the Foreign Office in 1947, meanwhile, handed off global responsibilities (support to Athens to suppress communist insurgents) to the U.S. But it wasn't long before Washington realized that prolonged economic stagnation in the U.K. and the rest of Europe was a recipe for social unrest and political polarization. And, since cooperation between Washington and Moscow was replaced with a Cold War and the threat of creeping Soviet-inspired socialism, efforts were soon made to resuscitate the moribund economies of Europe through the Marshall Plan.

"Ok," I hear you exclaim in exasperation, "what has this got to do with anything?"

Fast forward 70 years: Greece, under a heavy debt burden and its monetary policy determined by the ECB in Frankfurt, is today negotiating from what many consider a position of weakness. In a sense, it faces a choice between self-imposed “Austerity,” the “Temptation” of signing on to more loans from Brussels and the policies of "internal adjustment," while it too is pleading its case for “Justice” just as the Keynes did seven decades ago.

Austerity is an unknown. Would it entail "Grexit"? And how would other Eurozone partners respond if the Drachma was reintroduced at a greatly depreciated rate? Would we hear the refrain of “beggar-thy-neighbour” exchange rate manipulation that was heard in the 1930s and the erection of trade barriers? And what would be the consequences for the rest of Europe and the global economy, writ large? All this is unknown.

The implications of Temptation, in contrast, are clear. It represents a continuation of the status quo, which the Greek government has clearly rejected. The policies of internal devaluation have wrought an economic and social disaster it argues.

How will this story end? It remains to be seen.

A pessimistic reading of the recent past might suggest that creditors’ fear that generous terms to Athens would merely perpetuate Athens' spendthrift ways at the expense of frugal Northern Europeans could result in a rupture of relations, just as Keynes' entreaties to the U.S. Treasury were rebuffed by concerns that generous terms would facilitate the reassertion of imperial pretensions. While Austerity may not be the best option for Greece, the rest of Europe or, for that matter, the rest of the world, it may be the outcome. As suggested previously, this would be a leap into the unknown. Yet, once the costs to Greece and the rest of Europe are clear we could expect a change, just as the U.S. eventually realized that protracted stagnation in post-war Europe created a breeding ground for political polarization.

But there are grounds for optimism. Greek Finance Minister Varoufakis doesn’t speak in terms of default or repudiation. Rather, at the Brookings seminar today he sounded a conciliatory note, seeking sensible renegotiation of elements of the international support package that are counterproductive. Presumably, however, a resolution of the impasse would require a temporary pause or re-profiling of debt obligations to give policy corrections time to take effect as higher growth would, it can be argued (PDF), preserve asset values and make creditors as well as Greek citizens better off. And, speaking an hour earlier in the same Brookings conference room, German Finance Minister Schäuble expressed confidence that an agreement would be found.

Perhaps the gentle breeze that blew today in Washington, sweeping fallen cherry blossoms through the streets, was the “sweet breath of Justice between partners” that Keynes had longed to feel, but failed to receive 70 years ago.

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